Microsoft Turns To Software To Move Hardware

Microsoft announced two new phones yesterday, the Lumia 640 and the Lumia 640 XL. The inexpensive devices are designed to handle global communications, built with dual-SIM slots and the like. They also included something curious: Free Office 365 for a year.

The company currently offers a Surface bundle that includes Office 365, and a cheap HP laptop recently shipped with the same. To my knowledge this is the first Windows Phone device to come equipped with an Office 365 subscription. I’m vamping with Microsoft to confirm the point.

Given the low price of the phones, it’s an almost surprising move. Consumers will be able to pick up the larger XL device at its highest price point for around $250, sans a new contract. Office 365 costs between $70 and $120 per year, depending on the consumer package selected, and how it is financed. That’s a material percentage of the price of the phone.

Of course, the marginal cost to Microsoft to provide Office 365 to a new customer is essentially nil.

But is the company foregoing Office revenue to help make its money-losing hardware assets move more units? Or put more simply, is Microsoft curtailing a profit source to fuel a money pit? No, but there is some nuance to the situation.

What matters here is that whoever builds the hardware gets to decide what operating system it runs, and what apps come pre-installed. When Microsoft ships a handset, it comes with Windows — soon, Windows 10 — and apps that Microsoft would like you to use. It also functions with a user’s Microsoft account, to which the company has stapled other cloud products and services that it, again, would like more people to use.

So the sale of a phone for Microsoft, along with Google and Apple, is a simple way to grow market share for mobile services and desktop-focused cloud services. That doesn’t conclude our question, however, as it is simple to ask the following: If Microsoft wants to grow its revenue from services and software, why give Office 365 away at all?

The answer, as you have already come to yourself, is that Microsoft is passing on a potential sale of Office 365 for a year, to entice a customer to its mobile platform for likely longer than a year, and also bring them into its orbit of services that the user will, presumably, want to keep using after the free period has lapsed.
So that’s a sold phone, a good shot at a new Office 365 customer, and some income along the way from apps and search. From that perspective, the financial gambit makes sense.

Microsoft previously stated that its phone business would reach “operating break even for the Phone business in fiscal year 16.” Given that the firm has produced no new guidance, we can presume that the above fits under the projection’s financial rubric. It will be interesting to see how Microsoft includes the new subscribers in its quarterly reporting of key performance indicators, or KPIs, that include a number of consumer subscribers to the consumer side of Office 365.

An Effective Carrot?

At question is how enticing free Office is for consumers, in terms of how it might drive hardware sales, and how many users will convert to paying subscribers after their year of free access ends. From a margin perspective, the end-of-year moment is when a phone might actually drive profit: Sell the phone at break-even, give away Office 365 for free for a period, and then cash in on the massive margins that software can provide thereafter, presuming that the original purchaser subscribes.

A $100 software sale that was originally predicated on a hardware sale would grant pleasant margins to each business group involved, and the larger Microsoft corporation would be content as well, having both its halves turning over at a decent clip.

Given that a similar strategy has been deployed across phones, tablets and laptops, it is fair to point to a trend: Microsoft thinks that it can improve hardware sales, and thus adoption of its platforms, by using software as sweetener.

Spending margin, at least in theory, to build share, is hardly revolutionary. But if Microsoft can make it work in this case, a legacy business in transition will have assisted the company in pulling off a multi-billion-dollar bet. I suppose in the changing landscape of technology, that shouldn’t surprise.

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